Equipment Leasing Association Sales and Use Tax Update Western States June 8, 2005 Alan D. Floria PricewaterhouseCoopers LLP

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1 June 8, 2005 Alan D. Floria PricewaterhouseCoopers LLP P w C

2 Agenda/Contents Recent developments in the Western states with an emphasis on lease transactions Page 1

3 P w C Sales and Use Taxes Matter Combined state and local average rates going up! % in % in % in 1999 Ranges from 20% to > than 50% of state revenues National average is 23%, $105 billion More revenue than any other state and local tax except for property tax. Continuing to see frequent changes SSTP, new laws, regulatory rules, and judicial interpretations Page 2

4 US News and Trends: In General Revenue Shortfalls Continue -Education - Entitlement Programs - Revenue Declines From Prior Years Meaningful Revenue Growth Has Returned - Sales tax revenue increased 5.9% for July to September 2004 over the same quarter in the previous year. Page 3

5 US News and Trends: In General Sales and Use Tax Implications - Legislation Tax increases continuing Ending or narrowing of exemptions Broadening of tax base Defining and creating nexus - Presence definitions - Affiliate contract rules - Offshore entity contract restrictions Refund Limitations Page 4

6 US News and Trends: In General Sales and Use Tax Implications - Legislation Cont. Targeting the politically weak or disfavored - Sin taxes - Corporate Taxes - Out of state taxpayers New exemptions Tax amnesty programs Page 5

7 US News and Trends: In General Regulatory and Judicial Interpretation Where are we headed? Nexus In state and out-of-state vendor nexus Expansion of services performed nexus or tax base Narrowing or Growth of Exemptions State Tax Amnesty Programs Page 6

8 Arizona: Refinanced debt as sale/leaseback The refinancing of debt through a financial agreement labeled as a sale/leaseback did not constitute an actual lease subject to Arizona transaction privilege (sales) tax on leases, but was a nontaxable loan. An owner of equipment borrowed money to pay off its original debt for the equipment by purporting to sell the equipment to the lender under a bill of sale and receiving a lease of the equipment from the lender until borrowed money plus interest were repaid. The arrangement was styled as a sale/leaseback to keep the equipment off the owner's financial balance sheets. Although the owner's payments to the lender were called lease payments, the payments were not subject to sales tax, because title to the equipment and possession of the equipment never passed to the lender to create a genuine lease. The lender's only interest in the equipment was a security interest. Lease payments were based on the amount of the loan and interest rather than on the value of the equipment. Private Taxpayer Ruling LR , Arizona Department of Revenue, February 10, Page 7

9 Arizona: Recent Enacted Legislation Establishes a Managed Audit Program for Various State and Local Taxes The program applies to managed audit applications submitted from and after December 31, The managed audit is "a review and analysis by a taxpayer or the taxpayer's authorized representative of the invoices, checks, accounting records or other documents and information to determine a taxpayer's liability" for specified taxes. If the managed audit results in a determination that the taxpayer disputes, or if the Director rejects the findings of the managed audit, the taxpayer may appeal the resulting notice of determination. The taxpayer has the same appeal rights as if the Department of Revenue had conducted the audit. However, no interest or penalty would be assessed unless the managed audit discloses that the taxpayer committed fraud of willful tax evasion or that the taxpayer collected monies that were represented as tax but were not remitted to the state. Likewise, interest on refunds would not be paid if the refund is issued within 45 days of the determination. Page 8

10 Arizona legislation (S.B. 1185) establishes a method of percentage-based reporting to be used when determining payments for use tax, applicable to taxpayers eligible to utilize direct pay permits. Page 9

11 Arizona: Interlott Technologies, Inc. v. Arizona Department of Revenue (July 22, 2003) Nexus Issue An out-of-state company that leased lottery ticket vending machines to the State was liable for Arizona transaction privilege (sales) tax on the lease proceeds because there was sufficient nexus with the State through the company s maintenance of the machines by on-site employees. Although the company did not have a place of business in Arizona, the activities of its employees in Arizona, such as, performing preventive maintenance on the machines, training other to use and maintain them, and removing and moving them, constituted sufficient contact with the State to create nexus. The lease agreement was only the beginning of the company s business activity in the State and did not foreclose a determination of nexus. The company brought the machines into Arizona and kept its employees there to continue the business. Page 10

12 Arizona: Qwest Dex, Inc. was found to be subject to Arizona use tax for the cost of paper, but not the cost of printing White Pages and Yellow Pages telephone directories. Qwest Dex separately contracted for the paper and the printing. The court applied the dominant purposes test and held that since the printing can clearly be classified as a service rather than a sale of tangible personal property, such services are not subject to Arizona use tax. Qwest Dex Inc., v Arizona DOR Page 11

13 California: Consolidation of BOE, FTB, and EDD Amnesty Program Expanding Tax Base Page 12

14 California: Several proposed consolidation bills Generally, the consensus among the bills is that the FTB and the EDD should be merged into and supervised by the BOE Saw same thing last year Is the time right? Page 13

15 California: Sales and Use Tax Amnesty Program Program ended March 31, What was California Sales and Use Tax Amnesty? - A sales and use tax amnesty program for reporting periods beginning prior to January 1, Individuals and businesses were able to pay taxes and interest without penalties and without fear of criminal prosecution. - Hammer approach to amnesty. Page 14

16 California: Important Dates to Remember To Perfect Your Amnesty Application By May 31, Pay all tax liabilities and interest for each reporting period for which amnesty was requested in full or; By June 30, Make all payments under a previously entered amnesty instalment payment agreement. Page 15

17 California Penalties (if you did not participate in the amnesty program) - 50% of the interest on unpaid amounts for reporting periods beginning prior to January 1, 2003 and - Doubling of other penalties included in a notice of determination issued by the (SBE) on or after April 1, Extended Statute of Limitations - 10 years for reporting periods beginning before January 1, 2003, which were still open to issue a notice of determination as of August 16, 2004 (the day the amnesty legislation was enacted). - The extended statute of limitations does not re-open periods previously closed to audit or assessment. Page 16

18 California: Proposed California legislation (A.B. 9) would impose a tax beginning in 2006 on - Installation services - Gross receipts derived from certain specialized services, (including accounting and legal services). Similar bills proposed in prior years. Chances of passing slim. Page 17

19 California: Proposed legislation (S.B. 607) would set a $1200 limit for eligibility for the occasional sale exemption under California Revenue and Taxation Code section (a). Page 18

20 California: Proposed California Assembly Bill 911 would impose a 100% penalty on out-of-state equipment purchases for which a depreciation deduction is claimed if tax is not paid by the purchaser on such property. Page 19

21 California: Proposed California legislation (AB 671) would extend California s voluntary use tax reporting program and would increase the penalty for failure to remit taxes from 10% to 20%. Page 20

22 California: During 2003 and 2004, 431 cases were appealed to the California State Board of Equalization elected members for resolution. The Board upheld staff recommendations 77% of the time. 7% resulted in cancellation of penalties only, 15% resulted in some adjustment of the tax assessment, and 1% resulted in a cancellation of the liability. Page 21

23 California: California s new Managed Audit Program Requirements to qualify: Tax issues are relatively straightforward Your transactions are not subject to numerous exemptions You have the resources to do the work Benefits The audit is conducted by the taxpayer and/or representative Interest is assessed at 50% the normal rate Page 22

24 California: Manufacturer s Investment Tax Credit (MIC) Repealed The Manufacturer s Investment Tax Credit (MIC) was repealed by its own terms as of January 1, The 6% credit applied to qualified property that was acquired by, or subject to, lease by a qualified taxpayer. In general, the qualified cost was computed based on the original cost to the lessor. CA details the treatment of leased property for purposes of determining a taxpayer's eligibility for the MIC. Generally, the lessor must pay CA sales tax on the lessor's acquisition of qualified property in order for the lessee to claim the credit for that item of qualified property. Conversely, the lessee cannot claim the MIC for an item of property where the lessor acquired the qualified property without paying CA sales or use tax and the lessor instead collected use tax payments from the lessee measured by the lessee's rental payments to the lessor. However, the requirement that the lessor pay sales and use tax at the time of acquisition does not apply to "acquisition sale and leaseback" transactions. (CCH Sales and Use Tax Alert Vol 12 Issue 2, February 1, 2002) Page 23

25 California: Exemption for Sale, Leaseback of Public Transportation Equipment Extended. The sunset date for the California sales and use tax exemption for the sale or leaseback of qualified equipment used in the provision of public transportation services is extended from January 1, 2004, to January 1, The exemption applies to specified sales and leasebacks of qualified equipment and to purchases of leased or subleased qualified equipment by a public transit agency at the end of the term of the lease or sublease. In addition, effective January 1, 2004, a public transit agency seeking the exemption for a leaseback must submit specified documents to several state entities no later than five days after the closing of the leaseback transaction. Effective January 1, 2009, option purchases of leased or subleased qualified equipment by a public transit agency will be exempt if the purchaser and equipment were otherwise eligible for the exemption at the time the lease or sublease was entered into. Page 24

26 California: Affects of Heather Preston vs. State Board of Equalization on Leasing Transactions The temporary transfer of artwork for purposes of reproduction constituted a taxable lease that was not entirely exempt from California sales and use tax because the tangible artwork was physically useful and essential in the ultimate production of books and rubber stamps incorporating the copyright in the artwork. Without the physical artwork, the transfer contracts were essentially worthless. CRTC 6006(g). Page 25

27 Colorado: Sale/Leaseback Transactions Pursuant to a recent discussion with a representative of the Colorado DOR, it is Colorado s general practice to recognize a sale leaseback transaction when the sale/leaseback occurs within six months of the original acquisition date of the property. Page 26

28 Indiana: Enacted Amnesty Program Enacted Indiana legislation authorizes the Indiana Department of Revenue to administer an amnesty program. The program must run for an eight week period and conclude before July 1, 2006, and applies to liabilities attributable to taxable years ending before July 1, Page 27

29 Indiana: Leases of Forklift Equipment Taxable An equipment lessor should collect and remit Indiana sales tax on its leases and rentals of forklift equipment unless the customer provides a valid exemption certificate. With a valid exemption certificate, the taxpayer need not concern itself with the customer s records and supporting documentation on the exempt status of the leased equipment. Equipment and materials used in warehouse activities do not qualify for a manufacturing exemption because warehouse activities are not part of the production process. (Revenue Ruling No , Indiana Department of Revenue, February 10, ) Page 28

30 Kansas: Private Letter Ruling No. P , Sales and use-taxability of persons and transactions- Leases and rentals-party and event equipment (February 28, 2005) An out-of-state company that rents party and event equipment to Kansas customers is liable for Kansas sales tax on equipment delivered to customers in Kansas. A rental of equipment to a caterer is taxable, and caterers are not entitled to a resale exemption on equipment rentals.* An equipment rental for fewer than 31 days is not subject to Kansas tax if the customer takes delivery of the equipment outside Kansas and brings the equipment into Kansas. However, if the rental equipment is delivered to a customer outside Kansas and then brought into Kansas by the customer who rents it for more than 30 days, the charges for the equipment rental after the first 30 days are subject to Kansas sales tax. Page 29

31 Kansas: Equipment leases The Kansas local compensating use tax that was imposed by Ch. 147 (H.B. 2005), Laws 2003, and took effect July 1, 2003, applies to existing equipment leases. Because the law that imposes the new local tax does not contain a grandfather clause to allow existing lease contracts to continue to be taxed at only the state rate, both state and local taxes apply to these lease receipts for all reporting periods after July 1, Opinion Letter No. O , Kansas Department of Revenue, October 29, 2003 Page 30

32 Louisiana: Pursuant to the recently enacted Uniform Local Sales Tax Administrative Procedure Act, Act 469 (SB825) of 2004, the Dept. of Revenue has expanded the existing state sales and use tax rules to include provisions for local sales and use taxes. In addition to the expanded rules governing collecting, reporting, and remitting sales tax, the department has adopted additional provisions outlining the imposition of sales tax on lease and rental transactions. The lease or rental transaction rule requires initial local taxes incurred at the transfer of possession of the underlying property to be paid to the local taxing jurisdiction where the transfer occurred. In subsequent rental or lease periods, the tax will be paid to the local jurisdiction where the property is located. If the property is used outside of its primary local taxing jurisdiction, then the tax will be paid to the nonprimary local taxing jurisdiction; however, a credit for the taxes paid may be applied to the tax owed to the primary local taxing jurisdiction. (LAC 61:I.4301, 4303, 4307, 4311, 4401, DOR, effective Dec. 20, 2004) (Sales and Use Tax Alert Vol 15 Issue 1 January 15, 2005) Page 31

33 Nevada: Updated Lease Regulations Nevada Admin. Code pertaining to the applicability of sales and use taxes to leases and rentals of TPP was updated in December With leases and rentals where the parties to the lease are exempt entities, the taxability depends on whether the contract is in reality a true lease or a conditional sale. If the contract is a true lease, the lessor must pay use tax. If the contract is a conditional sale, the transaction is exempt. Additionally, several factors were listed that the Department of Taxation looks at in order to determine whether or not a transaction is a finance lease. Generally, a transaction is a finance lease if the only use of the TPP that the lessee is authorized to make pursuant to the lease is the leasing of the TPP as a sublessor to another party as a sublessee. (Nevada Tax Notes, No. 142, Sales and Use Taxability of Persons and Transactions Leases and Rentals) Page 32

34 Texas: (May 15, 2004) Eligibility for the manufacturing exemption for equipment rented or leased for a period of one year or more is determined by the actual term of the lease rather than the time that the equipment is at a customer's location. Equipment leased under a daily or monthly rental contract does not qualify for exemption even if the equipment remains at the customer's site for more than a year. (Letter, Texas Comptroller of Public Accounts, No L) Page 33

35 Texas: The Texas Court of Appeals, Tenth District, held that a lowincome housing provider that leases apartments from its parent, a for profit corporation, is not entitled to a charitable use tax exemption because the plain language of the statute requires that the applicant for the exemption own the property. American Housing Foundation and College Station Texas Southgate Village, Ltd. V. Brazos County Appraisal District Page 34

36 Utah: Leaseback found taxable under prior Utah law title transferred Matrix Funding Corp., et. al. v. Utah State Tax Commission (No ) Court rejected a financing company's claims that title never transferred in the original sale and that the subsequent leaseback was therefore not subject to tax. ZCMI sought financing for a construction project at a Salt Lake County mall. Beginning in 1991, ZCMI entered a series of sale-leaseback agreements with Matrix Funding Corp. involving property ZCMI had owned. Under the agreements, ZCMI sold the property to Matrix, which then leased it back to ZCMI. Title to the equipment passed to Matrix on the date of sale. The Supreme Court held that the subsequent leaseback to ZCMI constituted a taxable lease of tangible personal property. Sales tax applied to the lease, even if the lease was intended as a security arrangement, because the sale of the property from Matrix to ZCMI, with Matrix retaining a security interest, would have been a taxable sale. Thus, Matrix was liable for collecting sales tax on the lease transactions. (CCH Sales and Use Tax Alert, Volume 12 Issue 12 (July 15, 2002) Page 35

37 and Emerging Topics Utah: A sales and use tax exemption is extended through June 30, 2014, for sales or leases of rolls, rollers, refractory brick, electric motors, or other replacement parts used in steel mill furnaces, mills or ovens. The exemption was scheduled to expire on July 1, (Chap. 320 [HB74] of 2004) An exemption for sales and leases of semiconductor fabricating and processing materials for the period July 1, 2001, through June 30, 2004, is extended through June 30, (Chap. 169 (SB17) of 2003) (Sales and Use Tax Alert Volume 14 Issue 8 (May 1, 2004) (Sales and Use Tax Alert Vol 13 Issue 8 (May 1, 2003) Page 36

38 Utah: The Utah Tax Commission has proposed amending R865-19S-32 by eliminating the option currently provided to a lessee to treat a conditional sale as either a sale or lease for sales/use tax purposes. Page 37

39 Washington: Modern Staple, Inc. vs. State of Washington Department of Revenue (March 22, 2004) A company that sold fasteners and sold or loaned air tools to customers to apply the fasteners was subject to Washington use tax when the tools were withdrawn from inventory and loaned to out-of-state customers because consideration was present in such transactions and they therefore constituted leases. Department of Revenue and the taxpayer stipulated that WAC (b), which defines the term bailment, applied to the transactions rather than WAC (a), which defines the term leasing. The Board of Tax Appeals found that consideration was present in the loan agreements, and the transactions were therefore leases rather than bailments. Page 38

40 Washington: The Washington Board of Tax Appeals ruled that a credit union owed use and/or deferred sales tax for tangible personal property owned upon conversion from a federally chartered to state chartered credit union. Global Credit Union v Washington Dept. of Rev. Page 39

41 Wyoming: Machinery and Equipment Effective July 1, 2004, sales and leases of machinery used directly and predominantly in manufacturing are exempt from Wyoming sales and use tax. Exempt machinery must be used to produce a new product, article, substance, or commodity that is different and distinctive in nature, character, or use from the raw or prepared material that entered the manufacturing process. The manufacturer must be classified under the NAICS code manufacturing sector This exemption is only allowed through 2010 (CCH-EXP, WY-TAXRPTR , Manufacturing, Processing, Assembling, or Refining) Page 40

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